CHICAGO--(BUSINESS WIRE)--Fitch Ratings has placed Big Heart Pet Brands (BHPB) on Rating Watch Positive as indicated below:
--Long-term Issuer Default Rating (IDR) 'B';
--$225 million asset based loan (ABL) revolver 'BB/RR1';
--$1.7 billion secured term loan B 'BB/RR1';
--$900 million unsecured notes 'B/RR4'.
This rating action follows J.M. Smucker's (Smucker's) definitive agreement to acquire BHPB for $5.8 billion. The transaction includes $2.6 billion of assumed debt, 17.9 million shares of Smucker's common stock and $1.3 billion in cash. Smucker's has a commitment for a $5.5 billion senior unsecured 364-day bridge facility. Smucker's plans to finance the deal with a new bank term loan and long-term public bond issuance. Smucker's plans a relatively short closing for the transaction by April 30, 2015, after customary closing conditions are met. Smucker's has stated that it plans to refinance all of BHPB's debt. Per the BHPB notes agreement, there is a change of control provision where the company must offer to purchase the notes at 101 plus accrued interest.
The Positive Watch will be resolved upon the transaction closing, the repayment of BHPB's debt, or when Fitch gains more clarity on the combined company's capital structure, annual free cash flow (FCF) and potential pace of debt reduction. Fitch anticipates that the ratings will be upgraded multiple notches based on the current transaction structure and the company's greatly improved combined credit profile.
KEY RATING DRIVERS:
Smucker's Has Stronger Credit Profile Than BHPB:
Fitch anticipates that Smucker's credit profile will be much stronger than BHPB on a stand-alone basis, even with the incremental debt to finance the acquisition. Per Fitch, BHPB's total debt to EBITDA was 6.7x for the latest 12 months (LTM) ended Oct. 26, 2014, based on $2.6 billion total debt and approximately $390 million EBITDA. Smucker's pro forma leverage will be approximately 4x based on $6.5 billion total debt. Smuckers has stated that deleveraging with stronger cash generation will be a priority. Fitch estimates that leverage could come down to the low 3x range within approximately two years of the transaction closing based on preliminary FCF expectations. However, approximately $150 million cash-related one-time costs for severance and integration related expenses will reduce FCF in the near term, and will outweigh $40 million to $50 million synergies that Smucker's anticipates in the first full year. Synergies should accelerate in the second and third year to a level Fitch estimates near $150 million based on similar deals. Synergies mainly stem from supply chain and overhead. Per Smucker, pro forma interest expense is $200 million, up from the company's stand alone at roughly $75 million. Fitch estimates Smucker's EBITDA margins will remain in the 20%+ range, which is among the best in the packaged food industry. Based on Fitch's LTM EBITDA, the transaction multiple is about 17x; however, that factors in BHPB's weaker first half 2015 operating performance due to heightened marketing and cost inflation, which BHPB anticipates will improve in the second half.
Expanded Market Presence and Brands:
BHPB should benefit from the combined company's much larger North American retail presence, with $8 billion pro forma net sales in fiscal 2016, versus approximately $2.3 billion for the LTM on a stand-alone basis. Smucker's namesake brand, as well as other large food and beverage brands such as Folgers, Dunkin' Donuts, Jif, Crisco, Pillsbury, etc. will complement BHPB's well-known pet brands which include Meow Mix, Milk-Bone, Kibbles 'n Bits, 9Lives, Natural Balance, Pup-Peroni, Gravy Train, Nature's Recipe, Canine Carry Outs, Milo's Kitchen, and others. Pet food/snacks is benefiting from significant household dog and cat ownership. However, even with this larger, more competitive portfolio, center-of-store retail remains competitive with heightened levels of promotions and marketing eating into the pet products' profitability. The company's greater scale will be balanced with potential integration risk, Smucker's acquisitive strategy and the overall lackluster recent operating performance for U.S. mainstream food retail. While pet snacks and specialty are growing faster than pet food, these categories currently represent nearly half of the pet portfolio with the rest being slower growth mainstream pet.
Recovery Prospects:
The 'RR1' Recovery Rating on Big Heart Pet's ABL revolver and term loan B indicate that Fitch views recovery prospects on these obligations as outstanding at 91% or better. The 'RR4' rating on Big Heart Pet's 7.625% notes reflects Fitch's opinion that recovery for unsecured bondholders could have average recovery prospects given default of 31% to 50%. However, as mentioned above, Smucker's intends to refinance BHPB's debt in its entirety.
RATING SENSITIVITIES
Future developments that may, individually or collectively, lead to a positive rating action include:
Fitch anticipates that the ratings will be upgraded multiple notches based on the current transaction structure and the company's greatly improved combined credit profile, which includes pro forma leverage of approximately 4x and plans for deleveraging with FCF.
Future developments that may, individually or collectively, lead to a negative rating action include:
A negative rating action is not currently anticipated based on the current definitive agreement and financing plans discussed by Smucker's.
Additional information is available at 'www.fitchratings.com'..
Applicable Criteria and Related Research:
--'Corporate Rating Methodology' (May 2014);
--'Recovery Ratings and Notching Criteria for Non-financial Corporate Issuers' (November 2014).
Applicable Criteria and Related Research:
Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=749393
Recovery Ratings and Notching Criteria for Non-Financial Corporate Issuers
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=813588
Additional Disclosure
Solicitation Status
http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=979205
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